7/07/2005 @ 3:00PM

Coal: Alternative Energy's Best Bet

“Alternative energy” is a phrase that makes most investors cringe (if they have any sense). We all know that we’ll have to switch over to a new energy economy in the coming years as we outpace the supply of oil and natural gas. But if you’ve done any shopping in this area, you find that alternative energy companies are either giants that are dabbling in various solutions as an insignificant sideline or smaller companies that are much more focused on one type of solution and swimming in red ink.

And of course, alternative energy is a technological horse race, and an investor is just betting on the ponies when he plunks down his money on a possible technological breakthrough. But this is an area which is probably going to ramp up in intensity in the near future. So is there a sensible way to invest?

When you survey the landscape of the solutions that could give us a seamless switch from oil to whatever is next, you see a common denominator. The common theme seems to be that they all take about as much oil-based effort to facilitate as they give back in “alternative” energy, and they are many years away from being economically viable. But we may not have that much affordable oil or development time to implement the next energy economy. What we may see are some interim substitutes for our foreign oil refined fuels until we figure out the next non-fossil age.

A prime substitute is likely to be coal! We already use coal for most of our electricity. We’ve known how to make coal into high-grade diesel and gasoline since 1913, and we have about a 200-year supply of it in America, safe from geopolitical disruption.

Coal conversion into synthetic gasoline or “synfuel” isn’t exactly an unproven or textbook-only technology as most other alternative energy solutions are at this stage. Germany had 14 synfuel plants humming by 1939, supplying Germany’s immense war machine during World War II. I can think of no other alternative energy that has actually been deployed in real life at that scale.

Critics of coal say, “But it’s expensive.” True, it wouldn’t be `the good old days of $1 gas. But government studies done in the aftermath of the 70s oil shocks concluded that the coal process was a cheaper source of gas than oil is when it costs more than $35 per barrel. And if coal is converted chemically, it’s an relatively clean fuel that will cause about the same carbon dioxide greenhouse problem we currently have. Considering the alternatives, however, this may become less and less of a horror.

Some companies could benefit greatly.
Arch Coal
, the second-largest coal producer in the U.S. is an interesting play. Arch specializes in “compliance” coal, which is low in sulfur for electric power plants.

An even better prospect is a smaller company called
Headwaters
, which is based in South Jordon, Utah. But unlike most small companies in alternative energy, they are not drowning in red ink; they are engulfed in cash flow, profits and a sharply climbing revenue stream. In 2002, they derived 90% of their revenue from licensing technologies for converting coal to relatively clean gasoline. The company has working relationships with India, China and the Philippines.

Headwaters is the industry leader, but to diversify from the synfuel, they have built a post-combustion coal business in which they use the fly ash from coal burned at electric power plants to make a higher-quality, environmentally friendly concrete and other construction materials. This business now accounts for about half their revenues and is benefiting from the housing market.

Headwaters also does extensive pre-combustion treatment of coal to clean it of its pollutants, and the company is becoming a well-diversified “green chemistry” energy/construction company. This is the type of company offers practical solutions to the issues that the world will face in the near future.

Excerpted from the June 2005 issue of Marketocracy Marketscope. For more analysis and investment ideas from the m100, and to subscribe to Marketscope, click here.